Who's in the dock for the financial turmoil?

The UK, the US and many countries around the world are reeling from the current financial crisis. But who is being blamed and how valid is that blame?

Newspapers on either side of Atlantic are leading the inquest into just how the current economic crisis got this bad, gripping the United States and UK and spreading to Russia and Asia.

Several categories of individuals and institutions stand accused.

SUB-PRIME LENDERS

The root of much of the current difficulties lies in the sub-prime loans market, predominantly in the US. The sub-prime category refers to the category of borrowers at the highest risk of defaulting on their loan - perhaps those with a poor credit history or unreliable income.

The reason why this market became popular among lenders is simple, says Alex Brummer, City editor of the Daily Mail and author of The Crunch.

The turmoil seems unlikely to end soon

"The poorest people pay the highest interest rates," he says. In the low interest rate years after 2001, sub-prime borrowers might pay two or three times the interest of a prime borrower.

And if some defaulted, it wasn't the end of the world. Property prices were rising so fast in the US that the odd repossession wasn't a major problem. In an atmosphere of speculation, many people saw there was money to be made in property and so the spiral continued.

"There were strippers in Las Vegas who became real estate brokers," says Brummer.

But when the housing market took a turn for the worse, the problems started. Many borrowers were on deals that for the first two years had low rates and then switched to a much higher rate. Once house prices fell, borrowers who were struggling started defaulting on loans. Repossessed houses flooding onto the market caused a vicious circle.

By April this year, the FBI was already investigating 19 allegations of corporate fraud relating to sub-prime loans.

THE INVESTMENT BANKS

Of course, if it was just a case of sub-prime lenders suffering a rash of defaults, then the layman might assume that the damage would be limited to those lenders - like IndyMac and New Century - that have collapsed.

Architects of their own misery?

But these sub-prime loans were parcelled up and turned into complex financial products traded on markets all over the world. The esoteric nature of some of the products related to these loans has been blamed by many for the extent of the crisis.

"You have to ask what was driving the sub-prime market," says Brummer. "It was the demand from the Wall Street investment banks. It had such good returns. They were incentivising [the lenders].

"The PhD mathematicians found ways of doing sub-prime loan derivative products and an insurance system."

SHORT SELLERS AND SPIVS

One year ago, "short-selling" was a term that would have baffled most.

Now it is being widely blamed on both sides of the Atlantic for some of the worst symptoms of the current crisis.

A short seller effectively bets on the price of an asset, often a share, falling. Typically this is done by borrowing the share from the owner. The share is then sold and when the price drops it is repurchased and returned to the original owner. The short seller pockets the difference.

A headline from Britain's Daily Express sums up the mood: "Don't let the spivs destroy Britain." The Daily Mail's take was not dissimilar when it said: "Spivs, sharks and why the champagne corks were popping on meltdown Monday."

In the US, Republican presidential candidate John McCain may have spoken for many when he attacked some types of short selling.

The practice has now been temporarily banned for shares in many listed financial companies in both the UK and the US.

Overvalued shares

But the stance of Hector Sants, boss of the Financial Services Authority, is revealing: "While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets."

But there are some who say short-selling helps bring overvalued shares to heel.

The Securities and Exchange Commission kept in place trading rules that let speculators and hedge funds turn our markets into a casino

"All that short sellers do is kind of force prices which are the true price even faster," says Dr Thomas Kirchmaier, a member of the London School of Economics' Financial Markets Group and an expert in corporate governance.

In other words, what leads sellers to short is finding out a particular asset is overvalued. But the process can be traumatic and generate its own momentum.

"[There is a view that] all it does is speed up reassessment of an institution - in a few days rather than a few months," says Brummer. "But it is the suddenness that produces this immediate shock."

At the moment the speed of the price drop robs governments and central banks of a chance to formulate a plan for intervention, meaning that the next domino soon falls.

THE REGULATORS AND CENTRAL BANKERS

In the US, the three-pronged regulation of finance by the Treasury, Federal Reserve and the Securities and Exchange Commission has been criticised. In the UK, the roles of the Financial Services Authority, Bank of England and government has also been questioned.

John McCain has openly called for the head of the SEC to go. "The Securities and Exchange Commission kept in place trading rules that let speculators and hedge funds turn our markets into a casino," he said in one speech.

US Treasury Secretary Henry Paulson knows the markets well having been head of Goldman Sachs

And there are plenty who take an equally dim view of the British equivalent, the FSA.

"In Britain light touch regulation in the case of Northern Rock and HBOS was no touch regulation," says Brummer. "The degree of supervision on who becomes chief executive of these banks is just not good enough."

But some, like Brummer, feel the FSA faces a struggle, armed as it is with small numbers of staff paid far less than those they police.

For Professor Richard Portes, founder of the Centre for Economic Policy Research, regulators and central bankers have been extraordinarily myopic.

"They should still have seen a lot of warning signs, in particular in looking at off-balance sheet operations."

A key issue is the opacity of the banking system. If no-one can truly assess the liabilities of a given financial institution, how can they confidently lend it money? But this has helped people make money.

"You make money when it is opaque, you make money when you have got information that other people don't have," says Prof Portes.

And there are those who point the finger at the light touch of Alan Greenspan, chairman of the Federal Reserve from 1987 until 2006.

"He let them get away with murder," says Dr Kirchmaier. "At the same time he had this monetary expansion - he would always bail out the market."

The theory is that as financial institutions knew they were not bearing all of the risk, they have not acted as prudently as they might.

"You can't let these banks go down because the impact on society is enormous. It is the state who has to bail out the banks."

THE POLITICIANS

The first major casualty of the credit crunch in Britain was the Northern Rock bank, and there has been plenty of criticism of Chancellor Alastair Darling and Prime Minister Gordon Brown over the handling of its crisis and nationalisation.

The government in the UK, as in the US, has argued that this is a global crisis which cannot be put at the door of a handful of politicians.

But there are some who believe it can indeed, if only for the failure to speak out against certain excesses while the going was good.

"Politicians bear some responsibility in Britain," says Brummer. "We allowed a culture of credit creation. At the end of last year the amount of credit in the economy was roughly the size of national output - the highest it's ever been."

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